Good morning, and welcome to the Secureworks Fourth Quarter and Full Year Fiscal 2021 Financial Results Conference Call. [Operator Instructions] We are webcasting this call live on the Secureworks Investor Relations website. After the completion of the call, a recording of the call will be made available on the same site.

Now I will turn the call over to Paul Parrish, Chief Financial Officer. You may begin..

Thanks, everyone, for joining us. With me today is Mike Cote, our CEO; and Wendy Thomas, our President of Customer Success, who will join us for questions at the end of our prepared remarks.

During this call, we will reference non-GAAP financial measures, including non-GAAP revenue, gross margin, operating expenses, operating income, net income, earnings per share, EBITDA, adjusted EBITDA and cash flow from operations.

A reconciliation of these measures to their most directly comparable GAAP measures can be found in our web deck and press release, which are available on our IR website. Please also note that all growth percentages refer to year-over-year change, unless otherwise specified.

Finally, I'd like to remind you that all statements made during this call that relate to future results and events are forward-looking statements based on current expectations.

Actual results and events could differ materially from those projected due to a number of risks and uncertainties, which are discussed in our press release, web deck and SEC filings. We assume no obligation to update our forward-looking statements. Now I'll turn it over to Mike..

First, innovating and expanding the Taegis platform; second, ensuring the protection and success of our customers; and finally, accelerating our go to market. We recognize this year will be an important one and are committed to providing incremental disclosures on Taegis as the year progresses.

I am confident we have the right strategy to help our customers, partners and teammates while creating long-term value for our investors. I'll now turn it back to Paul..

Thanks, Mike. We made meaningful progress on our Taegis platform, which had a strong first year of growth. Taegis ARR ended the year at $55 million, and Taegis revenue grew to approximately $30 million for the year. Our margins remain healthy while we balance the right investments for our future and strengthened our overall financial position.

We generated more than $60 million in cash flow from operations for the year and ended with a record cash balance of $220 million. And for our total results, fiscal '21 revenue grew 1% to $561 million.

Gross margin was up 6% to $335 million or approximately 60% of revenue and EPS of $0.22 was up from $0.01 in the prior year, reflecting our team's solid execution as we position the company for future growth. Moving to our Q4 performance. We're excited about the momentum on our Taegis platform.

Taegis revenue was $11.2 million and demonstrated consistent quarter-over-quarter growth throughout the year. Taegis now represents 400 customers with 35% sequential growth, and $55 million of ARR with 31% sequential growth. These results reinforce our conviction that we can accelerate Taegis growth and scale the platform in the coming year.

Total Q4 revenue of $139.7 million was down 2%, primarily driven by a reduction in nonstrategic areas of the business as we pivot toward Taegis growth opportunities. Gross profit was $84.2 million, translating to 60.2% gross margin.

For Q4 and the full year, our gross margin percentage is up nearly 300 basis points from fiscal '20, reflecting pandemic-related cost benefits. The flexibility required to navigate the past year's environment also created new learnings, and we expect some of these efficiencies will continue to benefit us in the long term.

Operating expense was $84.3 million, up 2%, primarily driven by strategic investments in R&D. Research and development expenses increased to 20% of revenue, up from 15.7% in Q4 of fiscal '20 as we accelerate our security analytics platform development.

Sales and marketing expenses were 25.8% of revenue, down 340 basis points, primarily due to a severance-related cost impact including the prior year period and lower travel costs. General and administrative expenses totaled 14.5% of revenue, modestly above the prior year period. Operating loss was $100,000, up 1%, and EPS was breakeven.

Adjusted EBITDA was $3.2 million, up from $2.3 million on gross margin gains. Fiscal '21 adjusted EBITDA was $33.2 million. Turning to cash performance and the strength of our balance sheet.

Cash flow from operations was $32.2 million, down from last year's Q4 performance of $43 million, with the decrease reflecting our investments in the Taegis platform along with channel and marketing.

We ended the year in a strong liquidity position with record cash of $220 million, up from $182 million despite navigating through these uncertain times. Additionally, we have an untapped $30 million credit facility with an expansion provision of up to $60 million. Now for our outlook, starting with Taegis.

As Mike mentioned, we are focused on increasing the level of disclosure for this business. For the current year, we expect Taegis ARR of at least $150 million, up from a base of $55 million at the end of fiscal '21. This translates to revenue of $90 million to $100 million, up from approximately $30 million this past year.

We plan to drive new customer acquisitions by ramping our sales and marketing investments. And we anticipate an accelerated portion of existing customers will transition in fiscal '22 as they look to benefit from the additional capabilities offered by the platform.

Looking at the overall business in Q1, we expect GAAP revenue of $134 million to $136 million and a net loss per share of $0.16 to $0.17. We expect our non-GAAP revenue to be in line with the GAAP range and a non-GAAP loss per share of $0.02 to $0.04.

For the full fiscal year, we expect GAAP revenue of $535 million to $545 million, a net loss of $63 million to $71 million and a loss per share of $0.76 to $0.86. We expect our fiscal '22 non-GAAP revenue to be consistent with the GAAP range. Our revenue outlook reflects our shift toward partner delivered services as we scale our MSSP program.

Our non-GAAP net loss range is $18 million to $26 million with a non-GAAP loss per share of $0.22 to $0.31, reflecting several factors.

First, an incremental $25 million in R&D to extend the Taegis platform; second, an additional $15 million in sales and marketing-related to the expansion of our partner program and promotion of Taegis; and finally, a portion of the pandemic-related cost savings coming back into the P&L.

Adjusted EBITDA is expected to be negative for the full year in the range of $13 million to $23 million. We expect cash flow from operations to range from breakeven to a $10 million use of cash. This includes a use in Q1 driven by our annual performance payouts, offset by cash generation in the later quarters.

CapEx for the full year is expected to be in the range of $3 million to $4 million.

Finally, we will compete effectively in the security software market that is growing double digits, leveraging our differentiated expertise and approach including our leading position as the trusted MSSP vendor of choice, our understanding of the constantly evolving threat landscape, and our vendor-inclusive approach to telemetry.

This will be a pivotal transition period where we've already laid the foundation for a compelling long-term model, which we outlined at our December Investor Day.

A replay of the event is available on our Investor Relations page, and we've also added an abbreviated presentation, along with our quarterly web deck that highlights the key tenets of our vision and multiyear strategy.

As a reminder, in the next 3 to 5 years, we expect to generate 100% of ARR and 90% of revenue on the Taegis platform; unlock partner growth, scaling our channel business to 50% of our mix; and migrate gross margins to the mid-70s as a result of increased software sales.

Our journey to an integrated SaaS platform with rapidly expanding go-to-market capabilities will provide compelling future economics including a highly recurring revenue model, significant margin expansion and strong cash flow, ultimately creating sustainable long-term value for our shareholders. I invite Mike and Wendy to join me now for Q&A.

Operator, can you please introduce the first question?.

[Operator Instructions] We'll take our first question from Saket Kalia with Barclays..

It's Saket. Mike, maybe first for you. Can we just talk about the traditional MSS business to start? I believe Taegis products, like MDR, for example, could supplement or even convert customers from kind of the traditional MSS business that we know to something more automated and higher value, to your point.

Can you just talk about how that's going? And what customers -- what MSS customers are saying about that shift to Taegis?.

Saket, thanks for the question. Happy to do that. I'm going to tee this up, and then I'm going to let Wendy jump in since she's been integral in kind of moving forward with that effort. So we started the process to migrate or show our customers the capabilities on the Taegis platform in fiscal '21.

And we were selectively putting customers in cohorts with regard to the capabilities that we had and the incremental value we'd show them as we expanded the process. The receptivity and the incremental value they're seeing has been very strong.

It fits tremendously well with the majority of our customers, and we accelerated that process into Q4 and expect that acceleration to continue through fiscal '22 and, quite frankly, into fiscal '23. I do want to touch on one thing and then I'll bounce it over to Wendy.

From the perspective of -- there is, however, a portion of our customer base that we're doing much more customized solutions really relating to other platforms. And some of that business, quite frankly, won't fit in what we're doing from a Taegis perspective.

But having the capability on the -- over -- on the underlying Taegis platform with regard to the XDR capabilities, the VDR capabilities, the lot retention capabilities we've talked about, some targeted threat-hunting capabilities and incremental features and functions we're going to add over time through this fiscal year.

We're excited about the progress and the evolution of the progress we've had to date. So Wendy, now if you want to go into a little more depth and maybe touch on, to Saket's question, a little bit of the pulse and the things we're doing from a customer's perspective..

Sure, absolutely. So it's absolutely a great opportunity to take customers, particularly current MSS customers, to really, as Mike said, extend from primarily detection into more automated investigations and response support. And that's really the incremental value that our MSS customers see in moving to the new platform.

As part of the, what we call a re-solutioning process, when we engage those customers, we absolutely want existing customers, because we know them, to feel that as an upgrade experience, then it's been a great opportunity to just make sure that they've got full coverage and great security hygiene in place.

And so their reaction and really the time to visibility and value to them is incredibly fast, and that's kind of in the reaction. The ability to see things and move them through an investigation quickly is tremendous and that the time saved by my team has been also tremendous.

In fact, we have a lot of anecdotal customer comments around the hours that we've saved, but we did do a study with Forrester, I think that Mike mentioned around. It not only reduced SOC work by about 85%. For our average customer, they'll see productivity gains of about $500,000 over 3 years from just the automation of the work in the space.

So it's the -- that's the real value for customers, is speed to value and efficiency..

Touch on 2 other things, if you would, though, Wendy. Touch on the technology, the cloud-native system and the capability it leads to training -- turning the customer because we've got a lot of feedback on that, as well as the network effect, kind of the incremental aspect of the network effect..

One of the key features of the new platform also is integrated chat, but in a way that lets customers' teams really work seamlessly with our security experts through an investigation.

They can see the same thing, they can actively chat, they can confirm threat actor activity, was this a targeted attack, [money] attack in real-time so that it really extends or supplements the expertise on their teams as well and kind of has their back. And again, just makes that process faster and higher fidelity.

And of course, in terms of the ability to quickly benefit all customers with a cloud-native approach to security, the speed of our ability to improve the platform seamlessly for the customers to constantly add detections that we learn from our incident response engagements and investigations with current customers.

Our ability to deploy protections for them is so rapid that they can feel the improvements each week. And we help our sales team kind of position that with customers as well..

Yes.

I guess, the only other thing I'd add and then Saket, will have to [move], is the user group capability, right, which is different because of the way that it's architected, right? We set up a user group where people are able to -- customers and our super users, our employees are all able to work together in the environment to kind of drive the platform forward..

That's great, guys. That's super helpful. Paul, maybe for my follow-up for you. First of all, I appreciate the additional transparency and disclosure on Taegis. Maybe just kind of thinking top-down.

As you look at that 2022 revenue guide, can you just talk broad brush -- I mean, I guess we've got a Taegis guide as part of that in terms of $90 million to $100 million in revenue.

But as you look at -- how much of that revenue dollar is going to be coming from Taegis versus traditional MSS versus SRC?.

Yes. Thanks for the question, Saket. And I'm glad you appreciate the additional disclosures. We're excited about what we're doing around our new product Taegis product, and we're going to be providing more and more disclosures through the year as evidenced by our revenue guidance that we gave around Taegis.

So if you take that revenue guidance of $90 million to $100 million for Taegis, which is basically 3x the revenue that we had this year, SRC is going to be somewhat flattish, even though the mix within SRC will be leaning more toward IR.

As we go through the year, we see the benefits of our IR services and our customers are seeing that, and we see that as continuing to grow in that mix within SRC. And then the remaining number will shake out to be the old MSS platform. So if you just fall through that logic there, you can get to the mix..

Our next question comes from the line of Hamza Fodderwala with Morgan Stanley..

And likewise, really appreciate the incremental disclosure there. Maybe just a first question from a macro standpoint for you, Michael. Obviously, we've had some pretty significant breaches recently. Given Secureworks' sort of focus on threat hunting and response.

I'm curious whether that drove any incremental pipeline or if that's raising any customer awareness towards your platform. I know you've had some events around the incident and helping customers sort of respond to this. So just curious if there's anything that you saw in the most recent quarter..

Yes. First of all, thank you for the question. I think, unfortunately, anytime there are incidents, particularly when we've seen kind of the announcements that happened back to back to back over the last couple of months, it increases and validates the risk that exists out there.

And I think it's created a heightened desire from the Board level down because we are having a lot of conversations with Boards to figure out and ensure that processes and controls they can put in place and that they can work with their management teams to ensure that they're getting the appropriate prevention, detection, response and prediction, if you will, of where the hackers are going.

So we did see an uptick and did do some incremental IR engagements, which are continuing, quite frankly, at this point. And it did create opportunities for us to open the door and have some increased conversations and show people what we're doing from a Qualys -- from Taegis perspective on our platform and where we're trying to go and driving things.

I guess the other thing I'd sort of touch on from that perspective is that I think it's highlighted and what we've seen is an interest from our customers' perspective in a lot of conversations and not just trusting a single point product. And there's been an uplift in looking at how do they have checks and balances throughout their whole system.

Some are even looking at putting in multiple layers of defense, either at the network or the endpoint layer, or ensuring that they've got the full environment covered but in a duplicative manner or a controls and checking manner..

Got it. And just a quick follow-up for Paul. Just around -- I think there's -- correct me if I'm wrong, but some initial headwinds just around the transition as you shift some of the revenue to your partners.

Any sense you could give us for sort of normalized revenue growth in Q4, looking ahead given that dynamic as you try to become more of an ARR-focused company?.

Yes.

And are you looking at Q4 of FY '22's, when you say that? Is that your reference?.

I'm sorry, no, just -- sorry. This most recent quarter from a revenue standpoint and then in FY '22 from a revenue standpoint. Any color on sort of a transition impact or headwinds that we should think about when we think about....

Right, right. So we took that in consideration when we set the guidance for FY '22. And so that guidance is reflecting some headwinds from the switch over to partners taking some of the services as we continue to sell the software and then they take on the services. And that impact will start to shift more as we travel through FY '22.

So look at that growing mainly Q3, Q4, that type of growth in the shift over to the MSSPs..

Can I add to what you said, Paul, just to make sure? So in instances where we are moving customers, -- existing customers over, there's typically been an uplift in the ARR that they pay us, roughly 20% sort of uplift.

And it is what -- it's the key component of what has caused our overall -- the increase in our ARR on our overall customer base to $138,000 internally.

And then I think just to make sure where we are partnering with an MSSP or an MSP, and they pick up the services component, we, in those instances, are getting just the software revenue, and they are doing the services component of the work. And we expect that is a component of that, but a very small component at this point.

We expect that to increase, and that's what's in the guidance that I think has Paul referred to it. Sorry, I stopped as Paul was shaking his head, yes..

Yes..

Does that help?.

Yes. That's helpful..

Our next question comes from the line of Sterling Auty with JPMorgan..

I'd like to start by asking what kind of compensation is Hamza getting now that he's switched over?.

I don't think it was disclosed in the proxy..

Yes, exactly. Exactly. Mike, there's a lot of different types of MSSPs that are out there.

So when you talk about kind of the partner model, I'm kind of curious, for Taegis, what is the type of partner that you see this resonating most with?.

So Sterling, first of all, thank you. Great question. We are actually -- we started our pilot program last month on the MSSP partner program.

We have signed up both current MSSPs and we have signed up managed service providers who would like to become MSSPs, and are working with both regional players in those 2 categories and global players in those 2 categories, and have sort of -- are going through the learning process of which ones are taking a little bit longer to really get to where they want to move along and become a part of the program.

And they're both going through to understand the value proposition. So it's really a process around when the acceptance will happen with regard to their internal capabilities today. For example, an MSP has very little capabilities. They're really excited to move forward.

In our process, we've created a training program and a training certification program for one to become -- you can't just sign up and put your hand in the air. And so we can see through that program and who has passed the certifications, who's really interested in making the investment to do this.

In many cases, MSPs, particularly those that are focused on our target market, which tend to be what we would say, mid-sized, if you will, market, tend to move quicker because they see the value, the increased revenue stream, the opportunity and are excited about it.

Then we've been going through the program with the larger companies who understand it, but it's a little bit heavier of a lift for them to move their incremental existing infrastructure.

And the training is not just training on our platform, but it is actually training certified to show them our experiences, the workflows, the processes and all the things we've learned over the last 10 years, we put in their training system.

Does that help, Sterling?.

It does.

And my follow-up, I'm really curious, what does the gross margin for Taegis through that type of opportunity look like today? And what do you think, as you scale that business, what the gross margins will look like for it?.

So let me start, and then I'll jump it over to Paul. In our partner program, and then I'll get to your specific question, there's 3 types of partners we have signed up.

There are referral partners that would fit into the normal margins that we would provide, but they would be referring to us software sales works, the XDR, the VDR software application alone.

So it's typical software margins you would expect or the management of it, and we could do that management or as we continue to expand the MSSP program, the objective would be to move the management to our partners in many cases where it makes sense. There's resell solutions where the end customer versus referrals, so it'll be on the partner paper.

And then there's the example of the MSSP program we just talked about. And in the MSSP program, in those cases, the MSSP partner would be doing the services component. So to us, we would expect to see software margins..

Yes. And I discussed this during the Analyst Day and in the long term, as we get more and more of the mix of software, you'll see that flow through our overall margins.

And as we continue to grow the Taegis platform, we're exploring, when is the time for the appropriate disclosures on segments, and you'll start seeing that when we start disclosing segments as size and scale of that product continues to mature..

[Operator Instructions] Our next question comes from the line of Alex Henderson with Needham..

I was hoping you could talk a little bit about the mechanics around what you're spending on sales and marketing and to what extent you're adding additional reps, whether you're putting additional capabilities to support them.

Can you flush out that sales and marketing spend, where it's going, how it's being orchestrated, please?.

Sure, Alex. This is Mike. Thanks for the question. I don't -- I think I have it, but let me try and address it. And then if I don't, just let me know. So we are basically investing in various reps around the markets, around the globe in the different geographies. So we are continuing to expand.

We're investing heavily in the go-to-market side of the -- I mean, in the channel side of the house, in our efforts as we're expanding the channel through the MSSP program that we just talked about a few moments ago. We are also spending heavily from -- or increasing the amount from a marketing perspective.

And I guess, a really good example of -- a really good example of one of the collaborative efforts we're doing is the self-service demo and trial, which is on our website, which we released about a month ago and are seeing very strong acceptance of it and people that are in the process of actually in a 30-day trial -- free trial of looking at what Taegis does and how it operates.

So it's probably, I would say, a level amount of increased sales -- level amount of spend over the prior year in our direct sales organization, an increased amount in the channel organization and an increased amount of the marketing organization year-over-year..

I see. And just going back to the frictionless version. I'm a little confused why that requires an additional spend, if it's already been launched. If you could address how you're expanding that or what needs to be addressed in order to improve it..

It's cost around the self-service demos and trials..

That was just an example. So the self-service demo and trial, the frictionless version, if you will that you referred to, there's no incremental cost. It's just purely an example of the types of things that we are doing to kind of drive forward from a demand-gen perspective as a software company to give people the opportunity.

That's not -- I was trying to give an example of the types of things....

That's not -- that's not where the money is going. It's exactly -- right. I get it. So one more question, if I could.

Can you talk a little bit about what's going on with Dell, what's going on with their integration of Carbon Black, whether that impacts you guys at all, and how all of that -- those relationships are developing?.

Sure. This is Mike, again. So I guess the first thing I'd say is, as I've talked about before, we're really proud, and it works great, being a part of the Dell Technologies family.

Secureworks is a part of the Dell SafeGuard and Response as well as we're integrated into the Dell SafeBIOS prevention, detection and remediation of passive threats at the OS level.

We are continuing to explore expansion of our relationship across the Dell organization in relation to some of the discussions that I was talking about earlier in our partner program and how we can accelerate the opportunities for us to work together between Secureworks and Dell.

Within the VMware side of the house, as you touched on Carbon Black, I would say that -- a couple of things. One is our Secureworks XDR in just the Carbon Black cloud platform data.

So we work closely with the Carbon Black organization as we do the other market-leading endpoints in the marketplace that our customers may choose since we're vendor inclusive. And we incorporate the endpoint controllability from Carbon Black into our XDR system.

And as we sort of have said over time, our experience shows that point product security alone is not necessarily sufficient.

So we are looking -- we've seen how the adversaries avoided those point products or evaded those point products, and we're looking to bring in the Carbon black aspect of things as well as the other leading products at the cloud network endpoint and business systems into the Taegis XDR platform..

We'll now take our final question from the line of Brian Essex with Goldman Sachs..

I was wondering maybe if I could dig in a little bit on the Taegis customers. I guess, as of last quarter, you had over 5,000 total customers.

And I just wanted to understand what percentage of those -- I guess it's nearly 400 customers on the Taegis platform, where migration of existing customers, how many net new? And what that addressable installed base for incremental conversion might look like over time?.

Yes. About half of the customers on Taegis will represent existing customers. And so of that 400, roughly 200-ish are existing customers that moved over.

And we see, over time, that net new logos is very important, and that's why we've got so much emphasis on marketing spend and channel as continue to go after net new logos, and we see that growing in importance as we continue to develop the Taegis product..

The other part of the question, maybe, Wendy, you could address, which was effectively how many of our existing base of managed security service customers as well as the 5,000 includes consulting customers are either an opportunity to migrate over or move to the new platform or if they're not in that relationship, do we -- for example, the consultant-only customers, do we the ability to cross-sell or upsell them into what we're doing from a Taegis perspective and show them the incremental value..

Sure. From a consulting perspective, of course, we view that as continuing to be an important part of both lead generation opportunities for the platform, especially on the incident response side and even on our adversarial testing side of the house.

And the second is, frankly, the benefit of the learnings that we get from those engagements and making the overall Taegis platform and XDR and VDR products smarter. In terms of the -- so that will continue going forward.

In terms of the existing MSS base, as Mike mentioned, while there is a portion of that base that is, I'd say, more bespoke and not necessarily strategic to the go-forward approach, the majority of the MSS customers, as we were talking about earlier, are a great MDR transition play in the future.

And as Mike said, we really started that transition program in earnest back in third quarter and are seeing that accelerate as the -- as we build the muscle memory, we've enabled the sales team with a lot of tools and support for that process. And so we'll see that continue going forward..

I actually think it's a little more granular than that, to some extent, Wendy, in that some of those customers, there's a service that we're performing for them, that doesn't necessarily fit where we're going longer-term than a partner, somebody may pick up, but the customer may stay with us....

For the core....

For the core of what we're looking to do..

Absolutely. And some partners are very interested in that..

Got it. That's helpful. And maybe to follow-up on that.

Within your sales and marketing organization, I get that you're kind of in the process of building out the channel strategy, but direct reps, how different are those customers? And what percentage of your sales force is kind of up to speed on Taegis at this point?.

So great question. The customers are the same, the buyer is the same. The sales process is slightly different, which is why we've gone through a lot of training and enablement in our sales organization. And we basically have the sales team divided between sales consultants who are, really are, if you will, hunters.

And almost all of our sales consultants have closed a deal or more on the -- of Taegis. And the account executives side of the house, again, the vast majority of those individuals have been involved in moving customers or re-solutioning customers to the new platform.

And on the channel side of the house, our channel account managers are working closely with our account reps and our sales consultants in the process and are actively engaged in Taegis..

Thank you. I will now turn the call back to Mr. Parrish for closing remarks..

That wraps the Q&A, and I want to thank everyone for listening to us this morning and asking the questions. We value the relationships that we have with our investors. A replay of this webcast will be available on our Investor Relations page at secureworks.com, along with our Q4 and full year fiscal '21 web deck with additional financial tables.

Thanks again for joining us today..

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect..